Key Concepts and Summary

Key Concepts and Summary

Economic analysis of household behavior is based on the assumption that people seek the highest level of utility or satisfaction. Individuals are the only judge of their own utility. In general, greater consumption of a good brings higher total utility. However, the additional utility received from each unit of greater consumption tends to decline in a pattern of diminishing marginal utility.

The utility-maximizing choice on a consumption budget constraint can be found in several ways. You can add up total utility of each choice on the budget line and choose the highest total. You can choose a starting point at random and compare the marginal utility gains and losses of moving to neighboring points—and thus eventually seek out the preferred choice. Alternatively, you can compare the ratio of the marginal utility to price of good 1 with the marginal utility to price of good 2 and apply the rule that at the optimal choice, the two ratios should be equal:

\(\begin{array}{rcl}\cfrac{{\text{MU}}_{1}}{{\text{P}}_{1}}& =& \cfrac{{\text{MU}}_{2}}{{\text{P}}_{2}}\end{array}\)

Glossary

budget constraint line

shows the possible combinations of two goods that are affordable given a consumer’s limited income

consumer equilibrium

when the ratio of the prices of goods is equal to the ratio of the marginal utilities (point at which the consumer can get the most satisfaction)

diminishing marginal utility

the common pattern that each marginal unit of a good consumed provides less of an addition to utility than the previous unit

marginal utility

the additional utility provided by one additional unit of consumption

marginal utility per dollar

the additional satisfaction gained from purchasing a good given the price of the product; MU/Price

total utility

satisfaction derived from consumer choices